Tapping into your retirement plan to buy a house
Saving for a down payment is one of the biggest obstacles first-time home buyers face when it comes to owning a home. Another obstacle is thousands of dollars in closing costs. In other words, buying a home costs a lot of money. This is why first time homebuyers often consider tapping into their 401(k) retirement savings to buy a house.
Borrowing from your 401(k) can take as little as a phone call and a week. Most first time homebuyers will consider this option on the perception that a large down payment is needed to buy a home. But should you really withdraw money from your 401(k) to put a down payment on a house?
What is a 401(k)?
A 401(k) plan is a retirement program for people who work in the United States. It’s usually sponsored by an employer and allows employees to make pre-tax contributions toward a retirement plan. In other words, taxes are not paid on the amount you invest into the 401(k) plan. You only pay taxes on the income you don’t invest. And there’s no rule in a 401(k) plan that prevents you from withdrawing your money before retirement. There are, however, certain requirements to be considered eligible to receive pre-retirement money from the plan. For example, a life emergency could be what’s considered a “hardship” withdrawal from your funds and would be an exception.
A provision in the 401(k) plan exists which allows withdrawals to help first-time homebuyers with the purchase of a home. And these withdrawals typically come with a 10% tax penalty. A withdrawn amount from your 401(k) plan toward the purchase of a home will also be subject to income tax if you’re under the age 59½. However, your IRA custodian may report the distribution as eligible for an exception to the 10% penalty.
Borrow from It
Instead of taking a withdrawal of funds, home buyers can borrow from their 401(k) plan on the promise of paying it back. And so when you do “pay yourself back”, you earn interest on your loan. It’s a good way to supplement your home’s down payment. And since you’re borrowing from yourself, you have several repayment options available to you. However, during the period of repaying your 401(k), you’re likely to be prevented from making full contributions to your existing retirement plan. So depending on how much you borrow and how quickly you can pay yourself back, you could end up cheating your retirement plan out of years of contributions. And if your employer matches 401(k) contributions, you miss out on those too during the repayment period.
Should you borrow against your 401(k) and then leave the company for whatever reason, you only have 60 days to repay the remaining balance of your loan. It’s a gamble. So if you’re going to borrow from your retirement funds to put a down payment on a home, make sure you’ll be able to keep your job during that period.
Leave it alone
In today’s market, there are many low down payment mortgage options to choose from. And there are several programs available to today’s home buyers backed by the U.S. government that require a lot less than a 20% down payment. These programs include:
The Department of Veteran Affais VA loan
The Federal Housing Administration loan
The Federal Housing Financing Administration loan
The HomeReady™ program
The Conventional 97 loan
The US Department of Agriculture loan
The Good Neighbor Next Door program
So with various options to purchase a home with less than 20% down, you probably don’t need to tap into the 401(k) well. Mortgage rates these days are low, which allows for affordable payments so that you don’t have to touch the money accumulated in your 401(k) until your retirement.
You should only tap into a 401(k) loan as a last resort. So make sure you’ve exhausted all other options before dipping into your retirement funds. Ask a realtor about down payment assistance programs, housing authorities and non-profit organizations. Or seek out the help of a financial advisor before prematurely compromising your 401(k) retirement plan to buy a house.
Do you need advice on buying your first Tampa Bay home? Call us at 813-230-2439 for a free consultation. Or fill out our contact form below and we’ll get in touch with you soon!